While the Sensex declined 387.31 points, or 2.19%, the broadbased 50-stock Nifty of the National Stock Exchange (NSE) lost 120.55 points, or 2.26%, to end at 5,211.25. At one point, the Nifty dropped below the psychologically important 5,200 level and touched 5,116.45.

The rupee that had tested its three-year high last week and strengthened to 43.855 to the dollar fell to a five-week low of 44.735 from its Thursday’s close of 44.545. The yields on the 10-year bond fell 0.09% to 8.31%, tracking the US treasury yield, reflecting investors’ appetite for safer asset classes.

Rattled by fears of an imminent slowdown in the Western markets, investors across the world rushed to sell shares as fears of a double-dip recession in the US and worries of more sovereign debt defaults in Europe intensified. But by evening, after the close of market hours, sentiment changed somewhat as employers added more jobs in the US than forecast in July, the jobless rate fell and wages climbed, easing concern that the US economy is grinding to a halt. At noon on Friday, the Dow Jones Industrial Average was still in negative territory—down 1.7%.

Payrolls rose by 117,000 workers after a 46,000 increase in June that was more than originally estimated, Labour Department data showed in Washington.

“We may see some recovery on Monday following the global cue, but the mood is sombre now,” said Ananth Narayan, head of treasury at Standard Chartered Bank.

With Friday’s fall, the Sensex had lost 4.9% since Monday, its biggest weekly decline since October 2010 and its second consecutive weekly loss.

NSE’s India volatility index or VIX, a guage of risk and fear in the market, climbed 24% to close at 24.90 on Friday. Securities and Exchange Board of India chief U.K. Sinha told business channels the “risk management system was in place”. All settlements were taking place and the market watchdog was “closely” monitoring the situation, he said, calming the frayed nerves of investors.

Reserve Bank of India (RBI) deputy governor Subir Gokarn indicated that the global macroeconomic situation could change the central bank’s policy stance, which is focused on battling inflation. A softening trend in world commodity prices and the emergence of global recession concerns could have an impact, he said in Hyderabad.

“Fears of global recession have just re-emerged. I suspect that when we next meet in September, it will be an issue,” Gokarn said. “So far, there have been concerns about the extent of the recovery not being strong. (A) second recession was not in the realm of probability till very recently,” he said, referring to fears about the US economy.

Economists are seeing a ray of hope in the sequence of events and the stress on the global economy. “If a slowdown softens commodity prices significantly, that would be a very important input in policy formulation, as inflation would cool down,” said Saugata Bhattacharya, chief economist of Axis Bank Ltd. But he does not see any immediate change in RBI’s hawkish stance.

RBI, which raised rates by a steeper-than-expected 50 basis points last week, has been one of the world’s most aggressive central banks in fighting high inflation by tightening policy. It has raised rates 11 times since mid-March 2010 and bond traders had been pricing in another increase in September.

In its July monetary policy review, RBI had made it clear that fiscal consolidation is imperative to make the monetary policy effective in containing inflation in the world’s 10th largest economy.

But finance minister Pranab Mukherjee on Friday admitted that revenue collection may fall short of target as the pace of economic growth slows down, putting a question mark on the government’s ability to meet its fiscal deficit targets at a time when expenses are rising. “Up to now, revenue growth is satisfactory. Indirect tax collections have grown by 30% and (gross) direct tax collections by 26%. However, if industrial production slows down, it will have an adverse impact on future collections,” Mukherjee said. Trading on Friday started with both the Sensex and Nifty plummeting. The advance-decline ratio for the Sensex was 1:9 and 1:7 for the Nifty. As many as 89 stocks hit new lows on BSE. Reliance Infrastructure Ltd and Reliance Communications Ltd led the fall of Sensex stocks, losing 7.43% and 7.16%, respectively. Sterlite Industries India Ltd and Tata Steel Ltd were the two other big losers. Among sectoral indices, information technology, power and realty lost the most—over 3% each.

“The US is showing signs of uncertainty, which is disturbing. If the US markets go through such volatility, emerging markets cannot be insulated,” a top Credit Suisse official said.

However, he added that the long-term growth story of the emerging markets, especially India, is intact and Credit Suisse is advising its clients to rebalance their portfolio in favour of emerging markets.

“India’s problem is the slowdown in policymaking processes, including investment and expenditure plans... Foreign investors at the moment will look at India and other emerging economies, but if they face redemption pressure from their investors in the developed markets, they will pull out money from India,” he said.

The Indian market is the third biggest loser in 2011 so far. The Sensex has lost 15.62% this year, after Brazil’s Bovespa index (down 23.8%) and the Chile Stock Market Select index (down 15.93%).

“Foreign investors drive 80% of domestic equity volumes and unless we put our house in order, they will not pour (in) money. North Block (the finance ministry) can throw high growth numbers, but the investors have stopped believing it. We have to also understand that corporate India cannot perform at such high policy rates,” said Sonam Udasi, head of research at IDBI Capital Market Services Ltd.

“We are bearish, though there could be 100-150 points rally here and there, but the critical factor is that the globe is not looking good again,” he added.

vyas.m@livemint.com

Remya Nair in New Delhi, Anup Roy and Ravindra Sonavane in Mumbai, and Reuters and Bloomberg contributed to this story.